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Friday, 5 August 2016

The Bank of England swung into action on Thursday against the economic shock from Britain's vote to leave the European Union, cutting interest rates to near nothing and unleashing billions of pounds to cushion the Brexit blow.

In what one bank dubbed a "sledgehammer stimulus", the BoE cut interest rates 25 basis points to 0.25 percent and said it would buy 60 billion pounds ($79 billion) of government bonds with newly created money over the next six months.

It also launched two schemes, one to buy 10 billion pounds of high-grade corporate debt and another - potentially worth up to 100 billion pounds - to ensure banks keep lending even after the rate cut.

The Bank said most BoE policymakers expected to cut the rate to even closer to zero later this year.

"By acting early and comprehensively, the (Bank) can reduce uncertainty, bolster confidence, blunt the slowdown and support the necessary adjustments in the UK economy," BoE Governor Mark Carney told a news conference.

Sterling fell 1.2 percent against the dollar following the announcement, while British government bond yields hit record lows and the main share index rose by nearly 2 percent.

Carney said he had unveiled an "exceptional package of measures" because the economic outlook had changed markedly following the Brexit vote. The Bank expects the economy to stagnate for the rest of 2016 and suffer weak growth next year.

Finance minister Philip Hammond welcomed the rate cut and said he and Carney had "the tools we need to support the economy as we begin this new chapter and address the challenges ahead".

Carney said he was not a fan of negative interest rates, and he also rejected boosting the economy though "flights of fancy" such as 'helicopter money', which is essentially handing out central bank money with no strings attached.

The Bank's policymakers were not completely united on how to respond to the fallout from Brexit. The cut in rates and the measure intended to ensure banks passed it on to consumers - known as the Term Funding Scheme (TFS) - gained unanimous support.

But three policymakers - Kristin Forbes, Ian McCafferty and Martin Weale - opposed raising the target for quantitative easing government bond purchases to 435 billion pounds from the 375 billion total reached in late 2012.

Forbes also opposed buying corporate debt - something the BoE did briefly after the financial crisis.

SLOWDOWN AHEAD

While many business surveys show Britain's economy has slowed sharply and may even be entering recession, it is too soon for official data on how the EU vote is affecting output.

But the Bank is clearly worried.

"It is clear (it) is concerned about the scale of the slowdown that is coming for the economy," said Nandini Ramakrishnan, a strategist at JP Morgan Asset Management.

The BoE left its forecast for growth this year steady at 2.0 percent, as the economy expanded faster in the first half of 2016 than it had expected in May.

But 2017 brings a sharp downgrade to growth of just 0.8 percent from a previous estimate of 2.3 percent - the biggest downgrade in growth from one Inflation Report to the next, exceeding what was seen in the financial crisis. The growth outlook for 2018 was cut to 1.8 percent.

The BoE also revised up its inflation forecasts sharply, due to the big fall in sterling since the financial crisis, predicting it will hit 2.4 percent in 2018 and 2019. It said the costs of trying to bring it back to its 2 percent target in the immediate future would exceed the benefit.

The Term Funding Scheme is designed to make sure that the lower levels of interest rates now set by the BoE are reflected in the costs commercial banks charge households and companies to borrow funds.

Eligible institutions will be able to borrow four-year central bank reserves for an initial period of 18 months at rates close to the Bank Rate.

The lowest cost of funding, the 0.25 percent Bank Rate, will be for banks that maintain or expand net lending to the economy and the BoE will charge a penalty rate if banks reduce net lending.